Management Q&A

1. AGRI INPUTS

1.1 OSHEEN – DINOTEFURAN INSECTICIDE

As you are aware Osheen is a 3rd generation systemic insecticide invented in Japan by Mitsui Chemicals Agro Group (MCAG). PI Industries has registered and developed OSHEEN for the Indian market, in collaboration with Mitsui, Japan.

OSHEEN has been trusted as a most reliable solution to effectively manage the Brown Plant Hoppers in Rice for number of years in the leading Rice growing countries. It has also been tested and recommended by leading agriculture research institutes of Govt. of India on Rice crop and Cotton crop.

You are known for registering/introducing in-licensed products only after proper gap analysis. Is it correct to say OSHEEN is a uniquely positioned product, just like Nominee Gold was?

Yes of course. OSHEEN has been introduced through due process – has unique advantages of longer control period and better coverage. Because of its unique mode of action OSHEEN effectively controls the target pests which are not controlled by other molecules.

So what additional benefits does it bring when compared to other competing Insecticides?

OSHEEN has fast action due to which target pests stop damaging the crop after coming into contact of OSHEEN and start dying within few hours. It has systemic action and quickly gets absorbed into the plant, effectively killing the target pests present in the different parts of plant and provides longer and effective control on targets pests. OSHEEN has trans laminar action due to which spray done on the upper surface of the leaves gets translocated to the lower surface and controls the target insects hiding on the lower side of leaf.

But then it must be a more costlier product?

See you must realise for Farmers its not about a BRAND. For him the only thing that matters is cost of application/acre, and there OSHEEN delivers much better than many competing products.

So there has been enough efforts on farmer education?

Yes.

What about Data Protection? How many years will it have an uninterrupted run?

Well it has the usual 3 year data protection as per Indian laws. Post that a generic me-too source may be eligible to apply – depends on how good the product is. Even with a good product, effectively it will be 4-5 years before any effective competition emerges.

Any co-marketing efforts already on?

That will come later. First OSHEEN needs to be seen to be delivering the goods.

1.2 NOMINEE GOLD

Kindly update us more on Nominee Gold. You had allowed co-marketing of the brand with other MNC/innovative agrichem partners? What are the results?

As you are aware we had enetered into reciprocal co-marketing arrangements for Nominee Gold with a few MNC players. That allowed us access to some of their brands for co-marketing by us. We entered into these realtionships after due evaluation for optimising product portfolio in certain markets to offer complimentary product baskets. Results have been encouraging so far.

But you have also extended co-marketing to Rallis & Dhanuka too? Aren’t you diluting the BRAND if its available from everyone? What’s the deal there?

Again we evaluate these things from a relationship perspective too. They have reasonably big distribution network in certain regions and It ensures our presence in those markets.

You had mentioned last time if PI were to try and cover the whole market it would take us 10 years. Co-marketing would allow us to increase visibility and allow us faster coverage in 4-5 years? How far has that played out? How much additional sales has been generated for the product through co-marketing?

Should be 15 – 20%

Rice Herbicide penetration was mentioned last time at 5% levels? Where is that now?

It should be ~8-9% of total rice acreage.

So there is growth possibility definitely for next 4-5 years?

Much more than 4-5 years of good growth.

Now that Data Protection for Nominee Gold is over, what about emerging competition?

That was over last year itself. Few Companies have applied. It will take time before we see effective products on ground.

1.3 IN-LICENSED VS GENERIC IN-HOUSE PRODUCTS

In-licensed vs Generic products. Is the current ratio still 60:40?

It is about 65:35 right now

You had mentioned that this ratio will rapidly change, by now you had predicted 80:20 actually; going upto 90:10 eventually

That’s true, but take into account last year. Because of the pretty bad last year, we got behind. We should be there in the next one or two years.

You launched 2 in-licensed new products. Kindly educate us about In-licensed Pipeline vs Competition. What’s the process? How do you keep abreast/ahead?

We have ~8-9 products in development pipeline and several others at negotiation table. This is a continuous process and our Competitive Intelligence mechanisms giving us inputs long before products are actually out in the market. Our process cannot depend on assessment of pipeline of others. As you are aware, we have very strong in-house gap-analysis MIS culled from all over the country for prioritising our pipeline.

What’s the price/revenue mechanism with In-licensing Innovators?

It’s based on simple long term purchase contracts. We purchase the Raw Material – active ingredients or formulated product.

What’s the pricing strategy for new generation in-licensed products?

As mentioned before, end of the day the farmer has to see lower of application/acre and therefore, your product price proposition should be attractive for him.

There are quite a few new breed of competing products like Round Up and others. What kind of threats do you see for your product lines?

We think there is room for all to grow. We focus on identifying a gap and providing better yield/productivity for the farmer.

What kind of impact do you see of the Food Security Bill? Is that a positive?

This to my view should drive food production, productivity and yields have to go up substantially. Farmers will get incentivised. If Farmer is happy, we will be happy.

You have lot of exposure to the Rice crop. First through Nominee Gold and now Osheen. Have you seen much of Hybrid Rice? Is that growing rapidly? What’s the potential?

Yes this is true. However, Osheen is also doing well in cotton. Also we have several other products in fruit, vegetables and other field crops. Hybrid seed is rising and so is the research seed. Next wave of growth in seed may come from corn.

2. CUSTOM SYNTHESIS (CSM)

For the first time we have seen CSM overtake the Agri segment. Revenue Contribution in FY13 was 55:45 CSM:Agri. How long before this scales to 65:35? Strategically, is this a great development?

It’s certainly good to see CSM scaling up the way it has done in the last 2-3 years. However for us it is important to be able to grow both segments equally well. For two reasons:

1. This gives us a neatly de-risked/balanced business model
2. Agri segment – the domestic opportunity is huge. It’s a very low-capital intensive business. Given the strength of our model and the strength of the agri-business sector in India, this segment is poised for 30-40% kind of growths over the next 3-5 years horizon. This segment provides us the CASH to fund the scaling up of the CSM business.

Give us a sense of the split between Long term contract vs annual contracts in CSM?

~60% is in Long Term contracts while roughly 40% get negotiated annually.

And the Long Term Contracts are all guaranteed off-takes model?

Yes, Take or Pay.

You have cited deliberately not expanding $300 Mn order book (static for 2 years) – for flexibility in accommodating higher value/volume molecules that had some visibility.

That’s right. Keeping the Order Book at an optimum level gives us the flexibility to balance investments required for sewing in long term contracts for say 10 years. Accordingly you need to invest in plant for tapping new opportunities.

So any success there?

That is what you are seeing today. The ramp up is from that success. We had promised 30% but we grew by 60%, isn’t it. This is happening because we have retained the flexibility.

14 molecules in Commercial stage. Please give us a sense of the longevity of Molecules – new vs old?

Both old and new molecules. Some have been there for long. Some have dropped off to be replaced by new molecules. That is why you need the Pipeline.

Pipeline of 28 molecules. With a 40-45% success rate you hope to see 10-12 going to commercial success? Is it right to say you have pipeline that provides visibility for next 4-5 years?

As you know Pipeline keeps getting refined on a continual basis. We have a robust Pipeline is what I can say.

Please give us a sense of existing Customers. How many in Commercial stage and how many at R&D/Pilot stages?

Yes Divi’s Labs has EBITDA margins of 30-35%, but Asset Turns <2. PI has EBITDA margins of 20-25% with Asset Turns 2.5 to 3.Things should be seen in that context.

You have today ~600 Cr coming from 14 CSM molecules. Is that ~40-45 Cr per molecule?

(Laughs). Well different molecules have got added at different stages. They come in different sizes. Having said that it’s not so skewed also as say 2 molecules contributing 500 Cr and rest 12 contributing 100 Cr.

Sony-PI/Update?

Nothing new to report.

Why are your R&D expenses so low compared to other players?

If you are engaged in innovation research/ANDAs your R&D costs will of course be at higher levels. We on the other hand are involved with process research where costs are much less.

3. JAMBUSAR

We are starting to see good contributions from Jambusar. But project is delayed by 2 to 2.5 yrs?

All delays are attributable to delays in getting pollution clearances and the Environmental Clearances.

Given the 10 yr tax concessions already underway, is there a focus to ramp up subsequent phases?

Of course. We are already doing erection work for next phase.

First phase took 2 to 2.5 years. What’s the timeline for commercialisation of next phases?

May be 9 – 12 months.

Sterling SEZ progress. Would you say there are any risks to progress?

None at all. As you are aware Gujarat is a very progressive state. Everything is progressing normally.

We have already reached 90% utilisation at some 100-120 Cr. What happens to Asset Turn targets of 2-2.25x?

(Sighs). One must look at the total investment versus investment for Phase1 and then compute Asset Turns. Our existing Asset Turns are greater than 2.5x. Going forward you will see these numbers. Projects will come/being negotiated with these figures in mind.

What are you Long Term Debt goals. Do you intend to become Debt free in future? Interest Costs will continue to be low

Yes, that’s the goal. Interest costs will be low.

With Free Cash flows flowing in, are there inorganic moves being planned?

Yes, we are investigating.

We were visiting companies across Gujarat and came across your Panoli facility. We couldn’t help notice the severe smell/pollution?

We are not in the Perfume Industry, you know. (Laughs, from all around).

Did you notice it all along the highway? or only along our plant. This is a common feature across the belt.

So aren’t these things monitored by any Agency?

Let me state that India is at least 10 -15 years ahead of China in this aspect. We have been having very stringent norms since the last 15 years.

Gujarat Government has evolved even more stringent norms. There is online monitoring of air stream and water streams.

So how significant are the Pollution control/Environment Management Risks for your business?

We are at risk only if a) we are not adhering to Norms b) not investing to manage pollution/effluent levels. Environment Management is the largest component of our Costs.

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Disclosure(s)

Ayush Mittal: No Holdings in the Company; ; Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years; : ; ; : ; ;

Management Q&A

1. PI INDUSTRIES HAVE GROWN SOLIDLY OVER THE LAST SEVERAL YEARS. LAST 5 YRS HAVE SEEN IT CLOCKING A COMPOUNDED ANNUAL GROWTH RATE (CAGR) OF 22% CLOCKING ~720 CR IN SALES IN FY11 FROM 318 CR IN FY07, WHILE PROFIT AFTER TAX HAS GROWN AT AN ASTOUNDING 5YR CAGR OF 73% TO TOUCH 64 CR IN FY11 FROM 7.19 CR IN FY07, OR 9X IN THE LAST 5 YEARS.

Kindly share with us this journey and the significant factors behind this seemingly extraordinary success. What will make this performance sustainable?

In the late 90s PI Industries had to make a strategic choice – between 2 divergent paths.

a) Continue with the emphasis on our Agrochemicals generics business – Invest in creating larger capacities, expand to other markets, and inevitably fight the MNCs with cheaper generics in most such markets, OR

b) Embark on an uncharted path – but one that’s a win-win with the MNC agrochemical players – identify gaps in the offerings in the Indian market, identify MNCs not present in India, strike up exclusive marketing rights with them, and leverage our strength of marketing and distribution reach within the country.

The backdrop was like this. From the early 90s the EU region was seeing heightened awareness drives against agrochemical use side effects, contamination of water, toxicity, etc. At that time, there were some 900 or so Agrochemicals globally registered. Some 400 of these were on the hit-list and a fresh registration process was being initiated. Those products that manufacturers that thought they could defend/pass the new norms would be submitted for re-registration. Those that weren’t (resubmitted) would in-effect get banned. By mid 90s this movement had caught some momentum. The US was also seeing EPA regulations coming in around the same time, with heightened awareness & similar restrictions being proposed.

We made a call – for better or worse – that the generics export business might meet with increasing roadblocks and further heavy investment in the business might prove counterproductive. And decided to go with option 2 – a shift in focus towards innovative agro-chemicals and a win-win partnership model with MNCs – something that is playing out nicely for us, now. The success has started reflecting in the numbers in the last 2 years or so.

Having said that we will be the first to admit, that the other approach also has worked out quite well. Some of the generics players from India have done much better than we expected and seen tremendous success over the years and have grown enormously. The progress on EPA in the US somehow was slower than we anticipated. But if you look at their balance sheet, the cost of that capacity creation has been rather heavy.

Now for the other business segment – Process Research. Even here the seeds were sown pretty early. Infact our first CSM contract was signed in 1997-98, and we are still the sole supplier for that client. 2005 was a landmark year for this business with India becoming a signatory to the WTO Patent & IPR treaty, and patent laws being framed in India.

Till 2005 the size of the projects would be small. MNC players were very cagey about their products because they knew without any patent protection laws, their registration and product data is open to all. But from 2006, we started seeing larger project enquiries. They had seen us over last 12-13 years, and our respect for confidential data and Intellectual property. We had not reverse-engineered a single molecule, though one can say we had enough opportunities.

They had much more confidence – on one hand in PI’s process research abilities, and on the other, PI’s respect for IPR. And this has reflected in our numbers steadily ramping up over the last few years. In FY 08 we had done 54 Cr from CSM, going onto 130 Cr, 192 Cr, and 240 Cr in FY11. And this year we may achieve 320-350 Cr from CSM segment.

But why did this MNC outsourcers look at PI? Why were they not looking at other players in Agro chemicals or say Pharma CSM/CRAMS players?

You cannot run both Pharma and Agrochemicals manufacturing from the same plant – because of regulatory aspects & plant size issues. If a company wants to target both Pharma and Agrochemicals CSM business it will have to set up separate dedicated plants for the same. In the Pharma space you can set up small plants – the dosages are small, you can have large volumes from small plant sizes, and the returns are sometimes a healthy 35-40%. In Agro chemicals you can not have such high returns. So existing Pharma players were unlikely to be attracted to the agro chemicals segment.

PI industries focused on process research business with following characteristics a) patented early-stage molecules b) complex chemistry c) sole or 2nd supplier status and d) geographical exclusivity. It was a bold decision to fund the process research business back then.

In our opinion, of the agrochemical companies in India then, a couple of players had complex chemistry capabilities. But they were already deriving upwards of 50-60% of business from exports competing directly with MNCs in those markets. Now it didn’t make sense for a patent holder to invite outsourcing from a generic competitor, does it?

THE SHIFT IN FOCUS AWAY FROM REVERSE-ENGINEERED GENERIC CHEMICALS TO IN-LICENSING INNOVATOR COMPANY PRODUCTS SEEMS TO BE PAYING-OFF HANDSOMELY. THE CSM BUSINESS ROOTS TOO GO BACK MANY YEARS – SOME 14 YEARS ATLEAST, SO FAR WE COULD CHECK.

Kindly share the circumstances/strategic decision-making process within the company that made you focus on these 2 segments. It does seem that in both the segments you have an early-mover lead and there are fairly high entry barriers in place – Your comments, please.

The first part of your question – strategic decision-making, is covered in our discussion above.

Lets look at the Agri Inputs business – The contracts are signed for 10-12 years. Brands are in PI’s name. Registration is in PI’s name. And now we have moved on to giving other large players co-marketing rights for fully exploiting the potential of the brand and help in market development, as the scale required for adequate coverage is huge. Formulation manufacturing in India is only by PI. It’s a great win-win position to be in, because as you might have noticed we are being given co-marketing rights on some of their products, in exchange. We launched 2 MNC partner products recently in Q2.

And in CSM business – a) the contracts are signed for a term of 4-5 years usually b) the innovator customer needs to mention PI as the Active Ingredient (AI) supplier while registering in any country c) process efficiencies kick in campaign after campaign as the gap between theoretical norms and plant norms keep getting reduced. So the innovator has very little incentive to change his AI supplier and no one wants to rock a working combination as any change will set them back by a few years.

The 1978 diversification into mining and mineral processing and the energy metering business in 1980s were later hived off into separate companies. In Dec 2010 the (lower margin) Polymer compounding division was sold off to Rhodia.

The promoter family had 3 sons, in a joint family structure. The younger son is in charge of the family’s mining interests. The company saw potential in the large deposits of Calcium and Volestolite mines in Rajasthan and acquired the licenses. This company hived off as Wolkem India Ltd., today is the largest miner and producer of Volestolite in the World.

The youngest son looks after the Energy metering business. The promoters on a business trip abroad had found promise in PRI Ltd UK, and subsequently acquired it. The company supplies power and gas meters. Secure Meters is India’s largest energy metering company, today.

Today, all the companies are completely independent with no cross-holdings and independently managed. Mr Salil Singhal PI’s chairman continues to be non-executive chairman in other 2 companies.

Please share the company’s philosophy and thinking behind the decisions. In any business that you pursue, are there some key metrics that you look for? Is there now a single-minded focus, on Agri Chemcials and CSM business segments?

Well I would say the aim for all our business is to be a) in hi-tech areas – that should challenge us intellectually b) It should be inspiring us to strive for achieving greater heights c) there should be some synergies with existing businesses d) financially viable

If you look at the joint research centre with Sony, that’s a very prestigious, challenging and inspiring win for us. Sony came over to look at us on Hokkaido University, Japan’s recommendation that if you are looking for outsourcing, PI is the right partner for you. We were talking for over 1.5 years, and then they put us through a 6 month scrutiny, post which they were happy to sign up with us.

NOMINEE GOLD – PRE-EMERGENCE HERBICIDE (APPLIED WHILE SOWING). STUPENDOUS SUCCESS SINCE ITS INTRODUCTION IN 2010. IN LESS THAN 2 YEARS IT HAS BECOME ONE OF THE LARGEST SELLING HERBICIDE BRANDS IN THE COUNTRY.

This is the fist major branding success story from PI Industries? What has contributed to such a stellar success? Any USPs compared to existing pre-emergence or post-emergence Herbicides in the market?

It’s not correct to say Nominee is PI’s first branding success. Bio-Vita is the largest plant nutrient brand in India at 15000 MT in granules and 6 lakh tonnes liquid form. And that’s not even 1% of the potential in India!

FORA-TOX, FOSMIT, ROKET, and CARINA are the largest brands in India in their generic category. KITAZINE is another Innovative molecule that’s a big brand.

As brands, all of them are as big as Nominee.

But is it correct to say that in terms of numbers Nominee Gold is your first blockbuster brand?

Certainly the success Nominee Gold has seen is manifold that of the others. But as individual brands they are all big.

Nominee Gold certainly had its USP. All post emergent herbicides present in the market could tackle much lesser number of weeds than what Nominee Gold brought to the table. You have to see this in the context of 20-30 weeds/grasses that usually grow around the rice plant in any one location. Nominee Gold was the first broad-spectrum Rice weedicide in Indian market – the reason for its wide acceptability is its effectiveness against 20-30 such weeds vis-a-vis at best 5-6 of competing products.

How much does Nominee Gold contribute to total Agro-Chemical sales today?

As stated before for business confidentiality/competitive reasons, we prefer not to answer this question at this stage.

Had you anticipated this kind of success while test-marketing/launching Nominee Gold? Was this a one-off case, or do you think some of your other in-licensed products under launch consideration, can match up to this performance?

Yes, this was certainly expected. The reason lies in the Rice transplantation practice in India because of the weeds problem. Just imagine the labour/water wastage for years in India. We knew farmers would jump at the solution/benefits Nominee brought to the table. And then we all know how NREGA (for all the social benefits it brings) has made labour scarce and more costly.

What is the market-share of Nominee Gold among Herbicides in the market today? What are the constraints on growing this share?

It is very difficult to quantify exact share. Likely to be slightly in excess of 20% or so of the Rice Herbicide segment.

We have seen supplying not coping up with the demand, in certain markets. Would you say the “marketing challenge” for Nominee Gold is over but Capacity constraint is the key challenge?

It might be true of certain pockets in the first season of product introduction. However we are not aware of any such situation in the current year.

How would you quantify Agro-chemical manufacturing capacity as on date? What are the plans for FY12 and FY13 on this front?

We follow a bottoms-up demand assessment approach. We have an excellent Business Intelligence (BI) tool sitting on SAP. This tool is in-house developed and used for our business planning requirements. We have divided the country into 140-150 territories.

The territory manager assesses demand from his territory based on a parameterised form he fills up – e.g. total acreage, what crops , planting practices, products available in the market. He assessment is made assisted by his Regional/Zonal Manager. And then we have this aggregated data available on a regularly updated basis from all the territories – that is used as a vital input to our planning process.

We also get a broad sense of the demand/potential from our interactions with the farmer community at promotions and farnmer education programs. Based on all this, we assess at the beginning of the year full years demand, and schedule our imports with the manufacturers.

NOMINEE GOLD (BISPYRIBAC SODIUM) IN-LICENSED FROM KUMIAI CHEMICALS. BAYER HAD ALSO IN-LICENSED THIS FROM KUMIAI CHEMICALS AND HAS REGISTRATIONS (ACTIVE 2009) FOR GREECE, ITALY, PORTUGAL, TURKEY, ROMANIA, BULGARIA, PHILLIPPINES, AND SEVERAL OTHER COUNTRIES.

We have signed a long-term excusive marketing and distribution contract with Kumiai chemicals. This gives us the right to use their trademark in India. PI has registered the Nominee Gold brand in India and is the owner of the brand.

Why do you think Bayer did not in-license this for Indian market, for itself? Is it correct to say they missed spotting the growing use of Herbicide trend in India catching on, something that PI spotted. And now Bayer has partnered with PI for Nominee in India? Kindly share the terms of this partnership, and what does PI get out of this – access to Bayer’s larger distribution network?

No one company can do everything. Not even the MNCs with all their resources – there are bound to be hits and misses. Bayer may not have undertaken that study in India. DuPont has introduced Renaxypyr – another molecule that has done exceedingly well.

PI has the rights for Nominee in India. Now its our wish whether we want to do it ourselves or consider it in our interest to share marketing rights with MNC/other partners. We have chosen the partnership route giving them co-marketing rights; manufacturing can only be done by PI. We have taken co-marketing rights from a leading MNC player for 2 of their innovative products in exchange.

India is a vast country. There is enough scope for 2-3 players to grow the brand. On our own we may have captured the potential in 10 years. The trade-off is, now this can be done in 5 years perhaps. Also reciprocity gives us a much larger product basket to operate with. Another leading MNC player has given us 3 products while there are talks ongoing for 2 more with another leading player. Everyone benefits form this win-win approach. There is more visibility to the product, more accessability and that can only spur higher growth.

Is it correct to say certain factors like Labour Shortage (increasing rural MNREGA led economy) has contributed significantly to growing Herbicide use in India and led to Nominee’s success.

Yes. Covered before.

Have your other Herbicide brands like Altrazine, Fenoxaprop, Pretilachlor, Thiobencarb seen similar growths? Have Monsanto’s Butachlor/Alachlor grown as well? If not, kindly explain why?

Application and efficacy against limited weeds variety are the reasons for not coming anywhere near Nominees stellar performance, as mentioned before.

Nominee Gold is aimed at the Rice crop – Please educate us on the annual Herbicide spend on Rice crop in India.

If you combine the farmer annual spend on pre and post emergent weedicide and manual weeding it is in the Rs. 2500-4000 range. On manual weeding alone he ends up spending Rs. 2500-3000.

Nominee Gold would have reached some 4-4.5% of the total acreage under rice crop in India, currently.

CUSTOM SYNTHESIS BUSINESS (CSM) – SIZE OF OPPORTUNITY BEFORE PI. US$ 340 MILLION ORDER BOOK WITH TENURE OF EXECUTION RANGING FROM 2-4 YEARS. 14-16 PRODUCTS IN COMMERCIAL SCALE, WHILE SOME 24-26 PRODUCTS AT DEVELOPMENTAL PILOT & R&D STAGES.

Where do you see this business headed in the next 5 years? Do you anticipate some of the molecules to move from low volume (kgs) to full-blown CRAMS manufacturing (Tonnes) in the next 5 years? Post CSM commercialisation, typically how long is the growth life-cycle, and what is the total life cycle?

The CSM contracts are typically signed for 4-5 years. Unless we majorly goof up on something there is no reason why these contracts will not be renewed. The first CSM contract we signed in 1997-98, we are still the sole supplier to the client.

The patent life is 20 years. Typically the first 6-7 years are consumed in getting regulatory approvals and processes in place. So productive life cycle of a typical molecule is 12-13 years. The first 6-7 years are good growth years.

All our CSM manufacturing is commercial scale. We do not make any money during the process research and scale up stage, before it moves to commercial manufacturing. We could have had some fee-based structure there, but we chose to treat that as the investment phase. During process research stage the volumes is like 10 kg moving up to 1 tonne as scale-up happens. And then commercial scale manufacturing begins. Typical campaign size may move from 50 T to 100 T to 200 Tonnes.

What is the size of the opportunity before PI? And what are the challenges it faces in deepening the relationships with customers, while scaling on capacity and expertise?

The opportunity is huge. As mentioned before we are into CSM for patented molecules, where the manufacturer typically does not engage more than 2 sources. While the initial contract is for 4-5 years, the available life cycle is 12-13 years. In the early years the growth momentum is big. 1st year the manufacturer registeres in US, next year he registers in a couple of EU countries, the 3rd year he registers in Japan, 4th year adds more countries.

Then there are other verticals like Imaging chemicals, Pharma (early intermediates, pre API stage), Organic chemicals (the Sony JV). So the product basket is much more diversified today. The pipeline is more robust. Combined opportunity size before PI may be in excess of 10s of billions.

How significant is the competition globally? (Saltigo, Lonza, DSM, CABB (Kemfine)). Kindly share the main competitive challenges and how do you find PI positioned vis-à-vis competition?

Yes the names you mention are among the main competitors. Most of them are from Europe. Some in Japan, and China.

As far as we know, Patent Infringement is a big issue faced by Innovators in China. So the only outsourcing that happens there is in commodity chemicals and generics. And PI does not play in that space.

Now European players have their edge. They enjoy deep relationships with their clients and have had their confidence for several years. They are relatively more efficient in complex chemistry. But they have been in the business for 30-40-50 years. Asset Quality is now becoming a problem, as is ageing workforce with all their liabilities. If they have to expand to service a customers requirement, that expansion will come at European costs.

European players had the technology edge so far. But now if someone matches up to them on technology, then they have a difficult situation! We are also very clear that COST will not remain an edge forever in India. Along with our ability to meet complex chemistry requirements, PI’s edge, based on the feedback from our customers, is in process improvement. Customers are really happy at the response time and pace we bring in dealing with their requirements.

Who are your biggest customers? How much do your top 3 customers contribute to Sales? Does any one customer provide more than 10% of the CSM business? Kindly provide the geographical spread of customers between Europe, Japan, Americas.

We are unable to take any names. Our top 3-4 customers are contributing close to 60-65% of total revenues, with a couple of customers contributing more than 10% individually.

AGRI CHEMICALS BUSINESS – SIZE OF THE OPPORTUNITY BEFORE PI

Is it correct to say much of the growth in this segment has hinged on the exemplary success of Nominee Gold?

We have covered this before. Apart from Nominee Gold PI has had very good successes with many of its brands. While Kitazine is another innovative molecule, FOSMIT, FORA-TOX, ROKET, and CARINA are generic brands but the largest in their segments.

What levels of organic growth do you expect from existing products in next 5 years – not factoring in any new product introductions?

See 55-60% of our Agri Inputs business comes from Generics. That segment typically grows at 8-10% depending on the monsoon too. Innovative molecules from our pipeline and co-marketed products of MNC products should grow at much higher rates. Overall we see 30-35% growth being achieved.

Most of the Agrochemical majors like BASF, Bayer, Monsanto, Dow are also Seed industry giants. Kindly elaborate on this seemingly symbiotic relationship. And does PI Industries have any plans on this front?

It is symbiotic because you cater to the same customer set and can leverage existing marketing set-ups. Plus there is a huge huge potential of seeds business in India.

PI has done some soft marketing of seeds 1.5 years back -with MNC products. We have some ideas for coming with our own variety of seeds, and evaluating a few options.

What impact does pesticides-resistant varieties like BT cotton have on PI Industries Agro Chemical Sales. Apart from BT Soya and BT maize, how far is BT wheat/rice away from commercial introduction in India? Monsanto’s Round up Ready going off-patent, would it mean a rush of generics in the Indian market, and will that impact any sales of PI.

To look at this clearly, we need to understand the difference between Food and non-Food BT varieties. So while BT cotton has caught on, I have serious doubts if any BT -food seed will catch on in India!

The reason is Indian Palette is vary different. Even different regions have their marked preferences. The South Indian does not prefer the North Indian Basmati favourite. And if a North Indian has the rice a South Indian loves, he will say this rice is not worth eating!

I have serious doubt even with BT Brinjal. The Bengali will definitely boycott the BT brinjal – if he doesn’t get that particular flavour of his favourite brinjal!

And this we were talking about urban India – which is more exposed to global influences. But imagine the Rural India palette. I don’t see BT food seeds getting accepted in India easily. Atleast not in the next 10-12 years.

CUSTOM SYNTHESIS SEZ PROJECT – JAMBUSAR, GUJARAT. 22.3 ACRE LAND ACQUIRED. A TOTAL INVESTMENT OF RS. 125 CRORE EARMARKED FOR THIS OF WHICH 55-60 CR IS ALREADY UTILIZED.

What is the progress on this front? Have you secured any funding for the same? What are the terms? Is the balance 65-70 Cr to be utilized in FY13 only?

We have negotiated an ECB $20 Mn Term loan in October at Libor+3%. Repayment is after 2 years. We have drawn some amounts in October and November in 2 or 3 tranches.

Is existing capacities of CSM fully utilized? At full utilization what could be the revenue generation of existing as well as new plant separately, on a full year basis?

Actually in CSM business process efficiency kicks in from campaign to campaign. To give you an example one circuit that was producing 1 MT/day in 2009, is now producing 1.8 MT/day in 1HFY11 from the next campaign. This is almost double; sometimes dramatic improvements can be achieved from process optimization and efficiencies achieved. There is tremendous scope improvements because we are dealing with early stage products.

Together the 2 plants should generate 600-650 Cr in annual revenues.

When do you expect the next cycle to begin? Is it FY15 or earlier?

This really depends on the product pipeline and urgency at customers end. If some product takes on large volumes, there well may be a case for fast-tracking capex.

Please elaborate on the co-branding strategy. Is this the likely road from here on for new introductions? Who gains what from the partnership? Who is the registered owner of the brands in India?

This has been covered at length in earlier part of this discussion.

Kindly educate us on the unique functionality/application that these will bring to the market.

These products are again kind of filling a gap, that exists. Basically these have completely different mode of action and control (on the pests attacking these plants or vegetables), than currently existing products in the market.

Do your market studies indicate as big a market size as Nominee Gold for these 2 products?

As indicated before these have substantial potential in the Indian market.

Do you expect any significant revenue contribution in FY12? Does your 40% Sales guidance for FY12 factor in any contribution from the same?

Yes, these are factored in. The deals do not happen overnight, it takes atleast 6 months to put these kind of deals through.

Kindly educate us on the current business mix between generics & innovative molecules in this space. Given that you had substantial success with introducing blockbusters like Nominee Gold, is the focus shifting towards greater share of Innovative molecules?

Current mix is still 60:40 in favour of generics. But this is likely to change pretty fast in favour of Innovatives (in-licensed + co-branded products). We will be introducing new products. We will be launching 1 in-licensed molecule (a broad spectrum insecticide) in time for the next Kharif season, and as discussed there are many co-branded products under offer/discussion for introduction.

With the introduction of 2 new innovative molecules in Q2FY12, is this revenue mix strategised/foreseen to be changing significantly by FY13? Where will this mix be by FY2015?

We haven’t introduced any in-licensed molecules in this year. We introduced 2 co-branded products of MNCs. Yes the product mix should change decisively. Infact by FY13 you may see 70:30 in favour of Innovatives. FY15, difficult to tell…we want to reach 90:10 in favour of Innovatives, eventually.

AGRI-BUSINESS – THE THREE DRIVERS – NORMAL MONSOON, HIGHER CROP ACREAGES, HIGH AGRI-PRODUCE PRICES. WE HAVE SEEN MARGINS AND VOLUME GROWTH AFFECTED IN Q2. CONTINUOUS RAINFALL CONDITIONS IN LATER PART OF Q2 LED TO A SUB-OPTIMAL OPTIMAL PRODUCT MIX.

Kindly explain the components of this sub-optimal product mix.

a) Because of continuous rains, the skys remained overcast and cloudy for over 15-20 days at a stretch in most months b) farmers were uncertain …whether to employ the costlier (but more effective) liquid products which might get washed away just after rains c) consequently product choice shifted to lower cost granules products d) we were not so prepared on the supply side with granules products

We heard farmers opted for granules, which accrue lower margins (instead of high-margin liquid products). Why does the farmer not always opt for lower cost granules? Does PI have granule based products in its portfolio?

Granules based products work on the plant from the roots/stem by capillary action. In rainy conditions the farmers are still okay with the granules dissolving in the water and acting on the roots. Sometimes Granules are the only choice for a particular pest/application (no foliar liquid products available for that application). Sometimes Granules and foliar products are both available for a particular application. In such cases Granules are a poor second choice as they are nowhere near foliar liquid products (that act on the leaves and fruits and stem) in effectiveness.

Yes PI has some granules based products. BIO-Vita is available in both liquid and granular form. FOTO-TOX is available as granules, as are some of the other generic products in our product portfolio. Also Generics will not give us the margin expansions we seek.

See it depends on the way an agrochemical application works. At the time of registration itself you have to specify the application(s). You can’t just produce a granules version and manufacture/market it.

And your Nominee Gold – the flagship product? That is available only for foliar application?

Yes, Nominee Gold is not available for Granules application.

This may not be the first time PI has faced extended monsoon conditions! Could it have been better prepared?

Well the issue was of continuous overcast/cloudy conditions for more than 15-20 days at a stretch in most months. Our marketing guys were not prepared for it. It is very rare to have such conditions – No sun -for over 15-20 days at a stretch, in most months, at this time of the year. Besides, Punjab and Haryana had floods.

Some of the other pesticides companies like Insecticides and Dhanuka didn’t seem affected by the monsoon – they posted robust Q2 numbers. What do you think is different in their product mix/strategy?

Well we need to look at this from the right perspective. If you compare revenue growths in Q2, most have grown in between 15-25%. We have done better than that!

On the margins front, everyone has managed 13-15% EBITDA levels. Now for us Q1 was a super quarter and we did 21%. Our normalized levels are more like 18%, right. Now from 21% if you come down to 15%, it’s a big fall. But if you come down from 16-17% to 14-15% levels it is not seen as dramatic.

There was also one more reason. Q1 had seen unprecedented high take-offs of our products, because of preponement of onset of monsoons. People were afraid product may not be available later when they need them.

And as mentioned before we needed to invest in promoting newly launched products. That’s more a longer-term decision.

Do you see all drivers as favourable for H2FY12? Or are we more cautious now? And are we better prepared the next time similar conditions prevail?

The second crop season –water is always an issue. This time there is abundant water accumulation. Also the government is very keen to control supply side inflation.

All factors seem to indicate a better season ahead.

11. AGRI BUSINESS. IN-LICENSING VS CO-BRANDED INNOVATIVE MOLECULES.

You already have a pipeline of 7-8 co-branded products, is that correct? Any more co-branded planned to be launched in FY12? How many in FY13?

Yes, we should easily see some 7-8 co-branded products launched. We might be launching another co-branded product in next 2 months. FY13 should also see another 2-3 products launched.

You have indicated earlier share of innovative:generics likely to be 70:30 in FY13.

Well, it’s not fair to hold us to specific figures; these are very difficult to give. But we can certainly say direction will change. That the already launched and newly launched products will majorly drive the growth going forward. And if that is the case, then the change in product mix shifting towards Innovatives is inevitable. Now whether that will be 70:30, 65:35, or 60:40 in favour of Innovatives remains to be seen – how things play out.

Given that only 1 in-licensed product is likely to be launched per year, what is the likely share of co-branded vs own in-licensed in FY13?

Again this is difficult to predict. It depends on what volumes these products pick up. Percentages will depend on market acceptability and how the growth ramps up in specific products.

Kindly give us some indication on the margins front (co-branded vs own in-licensed). And vs generics.

All I can say is, it varies from product to product. And certainly there is some difference but it is not too much. But it is certainly much better than the generics.

Is Co-branding offered by PI only to MNCs? We understood that PI will offer co-branding only on a quid-pro-quo basis i.e. you also gain access to MNC innovative products. But we heard Rallis is also marketing Nominee Gold??

Yes, Rallis is also a Nominee Gold co-branding partner. And discussions are on for an innovative product from the company. Expanding distribution reach is certainly not the requirement, or objective.

12. CUSTOM SYNTHESIS BUSINESS – ORDERBOOK AT $325 MN AS ON SEP 30. 1 NEW MOLECULE INTRODUCED. GROWTH HAS COME MAINLY FROM RAMP UP OF EXISTING MOLECULES.

How’s the current outlook? Any slowdown in offtakes seen/expected from customers? Any impact seen from European customers?

You see the food situation is the same across the globe. We keep talking/meeting our customers every month/2 months. We have not seen any reflections/concerns in their demand slowing down, so far.

13. EBITDA MARGIN EXPANSION GUIDANCE OF 18.5% FOR FY12 (17+1.5). Q2 EBITDA @15% – PERFORMANCE HAS NOT MATCHED UP. HOWEVER, YOU HAVE MAINTAINED THE EBITDA GUIDANCE ON A FULL YEAR BASIS! AND COMBINED SALES OF RS 895 CR (575+320).

While you had guided for a 40% growth in Sales for FY12 in the Q1 conference call, it looks like the outlook has been tempered down to more like a 25% growth for the full year. On a reduced revenue base, how confident are you really of achieving the EBITDA guidance?

If we do an apples-to-apples comparison, we are very much there with a 40% plus growth performance. From the 720 Cr in FY11, if we take out the 65 Cr polymer revenue, that’s like 660 Cr. So with 900-925 Cr achievable this year, we are performing in line/better than the guidance.

And in terms of margins, if we see first half, we are already 1% up. So I would say we are in line to perform as per guidance.

Given that CSM business is more or less steady-state (ignoring the forex M2M for now), it would seem that you are pretty confident of the Agri-Chem sector outperforming in H2FY12. Please share the rationale for the confidence/optimism.

We have gone into the reasons before, and the need for looking at the numbers/growth on a like-to-like basis for the 2 years.

We hedge for the operating period – 12 months forward – against firm order positions. The Net inflow is hedged.

How much do you hedge of the Net inflow? Partial or Full?

Closer to full

70-80%?

Yes, 70-80%

Please give us a break-up of the 8.85 Cr M2M loss in Q2. Assuming you hedged at Rs.45 to US$, at 49 to US$, the M2M loss would be 4×20 ~8 Cr!

As on Sep 30 2011, we had outstanding forwards of $33 Mn. These were taken at 47+ levels (47, 47.25) while Rupee-US$ had gone up to 49+ levels (49.25, 49.5). The difference in these rates account for the 8.85 Cr, basically.

As on 30 Sep 2011, what is the quantum of firm contracts outstanding, and hedged contracts outstanding. How much is the net forex inflow expected? What is the hedged foreign currency exposure? Finally, Why do you need to hedge foreign currency – to mitigate foreign currency interest payout impact?

As mentioned before, as on 30 Sep firm orders on hand for 12 months forward is $95 Mn plus. Outstanding forward contracts taken is $33 Mn.

And this $33mn will be 70-80% of your net forex inflow for the period?

Yes, that’s right.

If the rupee keeps depreciating further, what can we expect? In Q2 Concall you have mentioned that being a net exporter, on a longer time horizon, PI stands to gain if rupee depreciates. Under current hedging policy/practice please explain how that would be achievable?

See in the short term – we expect things to balance out. But in the long term we should benefit. That’s because our CSM contracts are pass through –from campaign to campaign. At the end of the campaign we will be able to recover whatever gains/losses are booked.

But what about M2M losses?

These do not appear in the P&L.

But these M2M losses/gains have to be accounted for in the Balance Sheet, isn’t it?

Yes, you are right. But these need to be carried only till the time the campaign is executed. Once the orders are executed, the M2M gets neutralized.

Can you elaborate on this point, please.

See I can understand the concern if these forwards were speculative in nature (not backed by orders), then there can be big losses too. But when backed by firm orders, the M2M losses/gains are only notional … they will be neutralised, once the orders are executed. Its just a matter of time.

At worst, one can say that we did not gain (what we could have if left unhedged in current situation) but it is totally wrong to think we will make any losses!

15. ECB TERM LOAN EXPOSURE. YOU MIGHT HAVE TAKEN IT AT 49-50, BUT RUPEE IS ALREADY AT 52 TO A DOLLAR. YOU WILL HAVE TO REPRICE THE LOAN AND ACCOUNT FOR THIS (AS PER AS 30) IN Q3 AND Q4.

What is the Quantum of ECB loan? What are the Terms?

This is a long Term Loan. Total Loan amount negotiated is $20 Mn, at Libor+3% rates. Repayment is after 2 years. We have drawn some in 2-3 tranches in October and November 2011.

Are you planning to hedge this, capitalize this including forex till plant comes up? What are the risk mitigation measures contemplated, in view of rapidly depreciating rupee?

See this is a long term loan. As a company we follow AS-30 accounting standards. Till the time the M2M (loss) is not more than prevailing Indian interest rates, we can capitalize that. Depending on the situation at the accounting point of time, we will account for it accordingly.

Please understand this is a notional loss/gain over any accounting period and over the long term it may well even out. The amounts drawn so far have been taken above Rs. 50 to US$. So, we are not in favour of hedging this and taking additional costs on book.

16. JOINT RESEARCH CENTRE WITH SONY CORPORATION

Kindly comment on the progress, and revenue generation outlook? Has actual work on any molecules commenced? What is the visibility on revenue generation – FY13?

This is progressing well.

How is the deal with Sony structured? How much is the company investing in the R&D with Sony? How much is Sony spending? Who owns the intellectual property (if any) that comes out of this research?

We have dedicated a complete lab to the Sony project. All hardware assets are invested by PI Industries. Software assets are joint property.

We get a fixed fee during the process research and scale up period. Once CSM manufacturing starts, it will shift to our normal contracts model.

Who owns the intellectual property (if any) that comes out of this research?

The IP belongs to Sony. But if PI makes any process improvements, then the IP is jointly owned.

Is that written down clearly in contractual terms?

Yes.

17. R&D TEAM – PROCESS RESEARCH STRENGTH MUST BE A KEY OPERATIONAL AREA FOR PI INDUSTRIES.

Please share what kind of team PI has built up today, qualifications & profile of lead scientists, chemists, etc. What’s the strength today, and what are the plans of scaling this up going forward? How easy/difficult is this in today’s market conditions?

We have a team of 100-110 people in R&D. Of these 22-23 are PHDs. And 15-20 hold Masters degrees. The rest are chemists.

18. CRAMS SCALE MANUFACTURING. WE UNDERSTAND TODAY’S MANUFACTURING SCALE IS AT KILO LABS SCALE, WITH THE FOCUS BEING ON CUSTOM SYNTHESIS AND MANUFACTURING OF NEWLY DISCOVERED MOLECULES FOR MNCS.

Given the current pipeline, how far are we from needing to scale up investment in capex and processes for CRAMS scale (Tonnes) manufacturing? Please explain the nature of investments that will be needed to scale up, should an opportunity arise. If everything goes well, how long does the relationship typically likely to extend to (10-15 yrs?), once you start commercial manufacturing (CSM) of a molecule?

See when you have 250-300 Cr in Assets, you typically need some 10 Cr in Maintenance Capex. Expansion capex is managed by adding 1 more circuit or 1 more reactor, and the like. And that is linked to volumes. If the demand is more than plant design, then we need to go for further capex.

The second part of your question has been discussed before. Typically 12- 13 years of productive life of a molecule once its starts getting commercially manufactured.

Background

PI Industries (earlier Pesticides India) incorporated in in 1947, has Agrichemicals and Custom Synthesis as main business segments. It operates 5 multi-product plants at Gujarat & Jammu and one R&D unit in Udaipur, Rajasthan.

Main Products/Segments

Agrochemicals Product basket includes – Insecticides, Herbicides, Plant Nutrients and Fungicides. Insecticides contribute more than 50% of revenues, while Herbicides and Plant Nutrients contribute over 30% revenues. Rice crop and the Fruits and Vegetable segment are the top contributors, Cotton being the other significant segment. PI Industries has over 50 years of experience of manufacturing & marketing Agrochemicals in India.

PI Industries entered the Custom Synthesis business in mid 1990s. The custom synthesis business caters to process and manufacturing requirements of Innovator companies in the Agrochemicals, Pharma Intermediates, and Specialty Chemicals sectors.

From being a generic manufacturer of the reverse engineered off-patent agro-chemical products, PI has made the transition to in-licensing innovator company products for exclusive marketing rights to distribute their products in India. As per the company 40% of Agri-Inputs business is contributed by in-licensed products currently, and the mix is likely to go upto 50% with newer launches. PI purchases in-licensed products from the principals at a certain price and creates formulations/further manufacturing activities on these products to pack them under its own brand, and sells them in India. Most of it is branded sales, no bulk supplies to other players.

PI has a strong association with reputed companies such as Bayer, BASF, Chemtura and also a robust pipeline of exclusive co-marketing arrangements with top Japanese agro-chemical companies.

Custom Synthesis: ~35% of overall Sales in FY11, 100% exports catering to innovator companies from developed economies mainly Europe, Japan, and a small presence in US. 90% of these are all early stage, patented molecules.

With over 14 years of experience in custom synthesis business, PI has acquired strong competencies and proven its capabilities by working with more than 300 molecules at various stages of process development with up to 15 stage chemical reactions.

PI’s transparent non-compete and IP driven business model has earned it the confidence of clients while its core competence in process research and manufacturing has helped it partner global MNCs and Innovator companies -some ~30 active clients currently for agro-chemicals, pharma and specialty chemicals. As per the company, PI has more than 100 researchers and chemists to handle these assignments.

Bullish Viewpoints

Solid Track record – PI Industries have grown solidly over the last several years. Last 5 yrs have seen it clocking a compounded annual growth rate (CAGR) of 22% clocking ~720 Cr in Sales in FY11 from 318 Cr in FY07 . Operating profits have grown at a 5yr CAGR of 42%, while Profit after Tax has grown at an astounding 5yr CAGR of 73% to touch 64 Cr in FY11 from 7.19 Cr in FY07, or 9x in the last 5 years.

Consistent Improvement in Margins – Its good to see consistent upward trend in Operating and Net Margins in the last few years. FY07 and FY08 had Operating margins around 10%, going up to 14% in FY09, to 16% in FY10 and over 17% in FY11. 1QFY12 saw Operating Margins climbing to ~21%. As per the company, this is on the back of economies of scale with fixed costs getting spread over a larger base, and improving product mix and realisations in both its business segments. Clearly PI industries is operating at a different level, today.

Fast growing blockbuster brand(s) – During FY10, PI launched a new rice herbicide in India – Nominee Gold which had got a tremendous response from the farming community and has even been actively recommended by many state agricultural universities for adoption in rice cultivation. PI is expecting this product to achieve status of the largest rice herbicide in the coming years, contributing significantly to the growth of the company. With a portfolio of solidly growing products in-market and a pipeline of exciting new products, PI is poised to further scale up its business in FY12.

Innovative in-licensing model – PI works on an in-licensing model that helps it test market and work extensively in field promotion for newer innovative products, before looking to commercially launch the products. As per the company, there are 7-8 molecules in the pipeline under evaluation and registration stages and is targeting to launch 2 new products in FY2012. These are broad-spectrum insecticides with large market potential. All in-licensed products are based on long-term agreements and none of the products are due for expiry within next 5 years. Most of them have usage life of 15-20 years.

Agri growth drivers in place – As per the Management key drivers are quite positive. The Met department is expecting a normal monsoon. Early estimates of crop acreages are high and the agri produce prices are also running at an all time high. These are three key indicators which suggest that FY12 is expected to be a better year for the Agri-Input industry.

Strong order Book in Custom Synthesis – Current order book (1QFY12) is in excess of US$ 340 million with tenure of execution ranging from 2-4 years depending on different products. Most of the products are at start-up volume levels and are expected to ramp up significantly with time. As per the company, currently 14-16 products are in commercial scale, while some 24-26 products are at developmental Pilot & R&D stages. 65-70% of the Order book is from Europe, 20% from Japan, and the balance spread out.

Huge Capacity Expansion – PI Industries spent ~91 Cr on capital expenditure in FY11 mainly on expanded capacities at its Ankleshwar facility. It is also developing a SEZ project for Custom Synthesis at Jambusar in Gujarat on the back of the expanded order book, for which it has acquired 22.3 acre land. A total investment of Rs. 125 crore has been earmarked for this of which 75-100 Cr may be utilised in FY12, and the balance 25-50 Cr in FY13. As per the company this additional capacity may have a revenue generation potential ~325-350 cr.

Robust recent financial performance – Agri business had grown ~38% over FY10 and custom synthesis business logged a 23% growth over FY10. Overall Sales grew by over 32% in FY11 to ~719 Cr from 543 Cr in FY10. EPS on an adjusted basis grew by 57% to 51.19 from 32.69 in FY10. 1QFY12 registered a 59% increase in Sales to clock ~207 Cr (130 Cr) despite the polymer business sell-off, while EPS (adjusted for extra-ordinary income) surged 159% to over Rs. 20 (Rs. 7.8).

Bearish Viewpoints

Execution Risks – The main risks are on proper execution of expansion projects. Any delay in setting up enhanced capacities may impacted projected growth from custom synthesis business segment.

Effect of Monsoon – The Agri-Inputs business is largely dependent on the monsoon. While the FY12 Rabi crop (sown in winter months and harvested from May onwards) has reportedly been good, the Kharif crop (sown in the rainy season Jun-Sep) may still get affected by poor monsoons in the remaining months.

Sharp increase in Working Capital in FY11 – Working Capital/Sales shot upto ~29% in Q4FY11 as compared to ~22% in Q4FY10. Debtor days shot upto 90 days in Q4FY11 from 52 days in Q4FY10. Inventory dayssimilarly had climbed up to 72 from 52 days. The company maintained peak sales shift form Q3 to Q4 in FY11 responsible and normal working capital trends will resume in a couple of months. 1QFY12 indeed has seen debtor days down to 59, though Inventory days have increased somewhat to 75 days.

Huge increase in debt Levels in FY11 – Total debt sharply increased from 150 Cr in Q4FY10 to 248 Cr in Q4FY11. Company maintained this was mainly on account of short term unsecured loans to cover higher working capital requirements in Q4FY11. That this was not representative of the full year, company cited Interest costs for FY11 (18.19 Cr) being lower than FY10 (18.31 Cr). As Working capital normalises and sale proceeds of Polymer division (April 2011) accrues this would be brought down. 1QFY12 has indeed seen debt levels coming down sharply to 133 Cr. However going forward, additional capex requirements of ~75-100 Cr for SEZ project during the year is going to see increased debt levels.

Barriers to entry

Unique Non-Compete model – From inception PI has made trust-building the cornerstone of its strategy in custom synthesis and has refused to market competing products. As per the company, PI is the only Custom Synthesis business in the country where more than 90% of the molecules are patented or are at early stage of commercialization.

Strong Customer lock-ins – In the custom synthesis business, Innovator companies as a prudent strategy do not keep a single source. But usually for new products, for IP protection, and for other confidentiality issues they also do not keep more than two sources. If it is a huge global blockbuster kind of thing then they may have three sources, but usually not more than two sources.

Strong Brands – PI Industries has made the transition from being a generic manufacturer of the reverse engineered off-patent agro-chemical products, to in-licensing innovator company products with exclusive marketing rights to distribute their products in India. As per the company, PI brands are usually #1 or #2 brands in their categories.

Interesting Viewpoints

Strong Guidance from Company – On the back of a good monsoon for Agri-Input business and strong execution in custom synthesis segment, the company has guided for a 40% growth in Sales and an EBITDA margin expansion of 1.5% in FY12 (17.19% in FY11).

Sale of Polymer business – PI achieved successful closure of the sale of PI Polymer to Rhodia SA for 76 Cr. Post this transaction PI is completely focused on agri inputs and custom synthesis, both high margin and highly scalable businesses. PI booked 30 Cr of the proceeds as Extraordinary Income and the rest to be used to fund growth plans of existing business and/or bring down the debt. The disposal of the low-margin (EBITDA 10%) Polymer business is also expected to provide a fillip to overall margin expansions.

Joint Research Centre with Sony Corporation – PI industries signed an agreement with Sony Corporation to set up a joint research centre at Udaipur, named as PI-Sony Research Centre, it was formally inaugurated in January 2011. This R&D Centre will be engaged in developing commercially viable processes for molecules invented by Sony. These researched chemicals are expected to find use in futuristic products like flexible television, solar cells etc. This is a big testament on PI Industries custom synthesis capabilities. Work on several new molecules has already started, and revenue visibility is reportedly from FY13.

Currently India is amongst the lowest per capita consumers of pesticides at 380 gms per hectare while it is 2 kg/ha for China, 1.9 kg/ha for Europe and 1.5 kg/ha for the US. Also, out of the total crop area for rice, wheat and cotton in India, only 35-40% is treated with pesticides which indicates that the low penetration is likely to drive consumption of pesticides in India. [Source: Agrochemicals Market in India, FY11]

Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years